Qualified residential mortgages and the 20% down payment: no fear

As the Consumer Financial Protection Bureau’s (CFPB) summer 2012 deadline for formulating a definition for the qualified residential mortgage (QRM) approaches, criticism against current proposals has continued unabated.

Lenders have been some of the CFPB’s loudest critics, claiming they’ve learned their lesson from the failure of negative-amortization and interest-only loans originated during the last decade, and don’t need increased regulation. In a letter sent to the CFPB, 33 groups of real estate agents (including the National Association of Realtors), lenders and builders argued stricter regulations on mortgage lending is unnecessary and counterproductive; the real estate market needs stimulation, not stifling.

Under heaviest fire is the 20% down payment requirement, proposed by the CFPB. Opponents argue that demanding such a large sum of money up-front would exclude 60% of all “creditworthy” borrowers from advantageous loans. A lesser, 10% down payment would exclude 40% of all creditworthy borrowers from the market, according to the Center for Responsible Lending and the Center for Community Capital. The same data used to estimate these percentages indicates middle-income borrowers would have to wait anywhere from 15 to 24 years in order to save for the 10% down payment on a $172,900 house.

To improve lending practices, what is truly needed is not greater down payments, but higher capital ratios, tougher liquidity requirements and consistent stress tests for lenders. Detractors to the CFPB’s proposals claim the cause of the housing market crash was weak underwriting on loans, not insufficient down payments.

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The 20% down payment which QRMs would standardize is not a new concept, but has been historically preferred and recognized as the foundation for solid loans and real estate deals. Buying a home is a significant purchase, the largest purchase many will ever make, and requires financial planning and preparation.

Not only does a large down payment give a buyer equity in the house, it can also act as a litmus test to discern between those who are financially responsible and actually have the “ability to repay” a loan, and those who enter into a home purchase flippantly with no substance to back up the heavy commitment of a $200,000, 30-year debt.

The down payment for a $200,000 California low-tier home is no small sum to save, but neither is the task insurmountable. Unfortunately, the mentality of recent years has made the practice of saving foreign to many borrowers. Today’s average personal savings rate of 4% is barely half of the average personal savings rate for the period of 1952-1990 of 8-10%.

Granted, high unemployment rates have posed an additional challenge to bolstering personal savings in recent years, yet the 2006 boom-time savings rate of nearly zero suggests empty bank accounts have been due to more than lack of income.

$40,000 takes time to save. However, estimated timelines for middle-income borrowers to save a 10% down payment are based on the current savings rate, widely recognized to be comparatively low. The amount of time required to save a down payment may be significantly reduced by simply budgeting expenses — curbing personal spending in order to conform to previous saving rates of 8-10%.

Until they save enough money for a substantial down payment, many who wish to buy must rent. This means agents must adapt to the changing market direction and follow their clients to the arena of leasing and property management. Sales are far from sidelined in the current market, but residential rental properties are filling the widening gap between housing demand and stricter loan eligibility requirements.

2 Comments

Brent Calver
on May 31, 2012 at 1:15 pm

This issue is a conundrum. Larger down payments by and large keep people from walking from their obligation (too much to lose). However, down payment in and of itself is not a good determiner of ability and willingness to repay. There should be several factors at work;

1. The larger the down the lower the rate.
2. The better the credit, allow lower downs payments
3. Lower down payments (under 20%) should require mortgage insurance or seller carry back so the seller takes the default risk on low downs…

Lastly, loans with balloons and interest only loans do in fact have a place in real estate financing. The real problem with the mortgage melt down was the exotic ways in which mortgages were packaged, then repackaged and then repackaged again and again and again with too many wall street firms taking too many commissions and reinsurance… so much so that even a loan with 30% down would be underwater on a pay-off! The way it worked virtually every loan had a haircut and in theory every loans value was something less than the stated balance… What we need is SIMPLE mortgage backed securities, one level, one pool, that’s it!

If the only regulations the CFPB and other federal regulators were to change were those in my last paragraph, the market would heal itself. You can’t heal something that was made something less than whole to start!

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